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Commentary
Global Cash
Management Market Forecast
Q2 2021 Will Goldthwait
Portfolio Strategist,
Global Cash and Fixed Income
Investment Management Teams
The second half of 2021 could prove both dull and exciting, depending on a variety of factors:
debt ceiling resolution, a taper tantrum, money fund regulation, and crypto or stable coins. In
the first half of the year, we saw continued growth in cash holdings. With those cash increases,
came challenges of excessive balances presenting to both banks and money market funds. The
Federal Reserve’s (Fed) Quantitative Easing purchase program continues to add approximately
$120 billion of new reserves (cash) each month and the money markets have reached a point
of saturation that could pose a problem. How is too much cash a problem? Banks can no longer
store funds for their clients due to swelling balance sheets and the impact of required regulatory
capital and liquidity ratios. Some of this cash has flowed into money market funds and other
short-term debt investments causing certain rates to reach zero and negative yields. As investors
continue to seek returns above zero, they reach out on the duration curve and down the credit
curve. This additional risk could pose a challenge should rates become more volatile.
The Fed: There were no big surprises at the Federal Open Market Committee (FOMC) meeting
last month. As is typical, the committee tried to downplay any subtle changes to their standard
language. In fact, when speaking to a change in policy language, Chair Powell noted, “you can
expect us to drag our feet a little on that, because that is what you do with statement language”.
We could not help but laugh and remember the famous Alan Greenspan (Fed Chair from 1987
to 2006) quote: “I know you think you understand what you thought I said, but I’m not sure you
realize that what you heard is not what I meant.” Thus marks the plight of those trying to read
between the lines and forecast what the FOMC will do at future meetings. There were some
hawkishness to some of the data and Chair Powell cautioned on applying too much weight to
the “dots”. This can’t be over emphasized: the dots are estimates and estimates can change
depending on the economic data.
Key takeaways and what to expect:
• The median forecast for the end of 2023 climbed 50 basis points (bps) — from 0.125% to
0.625% — versus an expectation of only one hike in 2023. There is hope of a future rate hike.
• The Fed talked about talking about tapering. I expect a September announcement that their
asset purchase program will begin to wind down in January 2022.• We saw a big jump in near-term inflation forecast, but 2022 and 2023 remained virtually
the same, implying their view of inflation as transitory but perhaps now over a longer period
of time. Chair Powell sounded more open to upside inflation risks but continues to lean on
‘transient’. We don’t see inflation as a near-term or long-term risk.
• The Fed’s statement showed few changes, albeit a slightly more positive spin on
economic growth. Emerging from the COVID-19 lock down will be long and challenging
for certain sectors.
• The Board of Governors voted unanimously to raise IOER and ON RRP by 5bps.
Thank goodness!
The FOMC’s next meeting is July 28th. We don’t expect much news from that meeting but
would anticipate additional discussion around tapering of the asset purchase program. Also
keep an eye on the Jackson Hole Symposium; this would be a good venue to hint at the taper
of purchases. The September FOMC meeting is a good time to announce the wind down of
the program in January of 2022. We would expect a reduction of $10 billion per month over
12 months in equal proportions ($7 billion US Treasury and $3 billion MBS). We would not
anticipate any accelerated reduction in MBS over Treasuries or on any particular part of the
US Treasury curve.
Outlook: The rates outlook in the cash markets will be more of what we saw in the first half of
the year. Although the Fed Funds Futures curve has steepened in 2023, providing some hope
of a rate hike, the near-term prospects of any lift-off are dim. Treasury bill (T-Bill) supply might
provide a glimmer of hope for some upward rates pressure. Some estimate there could be an
additional $300 billion in new supply in the second half of the year, but not before a debt ceiling
resolution! Even with that supply, it seems unlikely that short-term bill rates could move materially
higher without another tweak in the RRP. After the RRP adjustment, 1-month T-Bill yields were
higher by 2bps but as of this writing they are almost 5bps higher from their lows in May. One-year
T-Bills are only 3bps higher from their lows in May at the time of this writing; there is simply too
much demand. The take-up at the Fed’s RRP (the Fed receives cash and pledges US Treasuries)
will remain very large. Currently we are seeing daily volume significantly higher than the
previous zero interest rate cycle with volumes reaching a record of $991 billion on the June 30
quarter-end (Figure 1).
Figure 1 1,200 Billions $
Fed’s Reverse
Repo Allotment 1,000
(Since Inception)
800
600
400
200
0
Dec May Oct Mar Aug Jan Jul
2013 2015 2016 2018 2019 2021 2021
Source: Federal Reserve and Bloomberg as of July 2, 2021.
Market Forecast 2It seems odd that the Fed’s purchase program puts cash into the market ($120 billion per month)
and then the Fed’s RRP takes cash back out of the market (over $600 billion on average per day
in the month of June), in such staggering quantities. At what point does this exchange start to
decline? Perhaps not until the Fed begins to shrink their balance sheet or the private and public
sector start to spend their accumulation of cash.
The credit market has also seen dramatic demand that has caused yields to reach all-time
lows. The 3-month Libor index reached a historic low of 0.118 on June 14th. Since the Fed raised
RRP and IOR by 5bps, yields have risen but only modestly; 3-month Libor was 0.145 on June 30.
All the while, outstanding commercial paper (CP) debt has risen. Over the past nine months the
CP market has grown by almost $300 billion at its peak before contracting to $1.16 billion
at month-end (Figure 2).
Figure 2 1,280 Billions $
Total CP Outstanding
1,200
1,120
1,040
960
880
800
Jul Oct Jan Apr Aug Nov Feb Jun
2019 2019 2020 2020 2020 2020 2021 2021
Source: Federal Reserve and Bloomberg as of June 30, 2021.
So with additional supply, why are rates falling? There is speculation that there is a new buyer in
the market: stable coins, also known as token currencies. Token currencies are new to the capital
markets. They have a hard currency backing them (like USD or EUR) but allow users to trade
that token currency on distributed ledger exchanges. They are different from crypto currencies
but often trade in ‘pairs’ (one token with one crypto). Crypto currencies do not have any assets
backing them and their value is based on demand (like baseball cards or Beanie Babies, for
those old enough to remember). One token currency that has been in the spotlight and received
some attention from regulators is Tether. A recent presentation by Boston Fed President
Eric Rosengren, noted that Tether owns approximately $20 billion of CP (the asset that backs
their token), making Tether the second largest CP investor. We will be watching this space closely
over the coming months and years, both for the risks that it poses but also the opportunities that
might come. Could a money market fund back a token, allowing a more dynamic exchange of
value? We will see.
Economic Data: There remains significant noise in economic data. The sudden stop and,
seemingly, sudden start in certain sectors of the economy have wreaked havoc on the data. It
will take a long time for this to smooth out to pre-COVID norms. We will continue to focus on the
employment gains (payroll) and decline in the unemployment rate. As we have said many times,
the Fed’s new policy framework puts more emphasis on employment and less on inflation, given
the number of years inflation has remained below the 2% target (Figure 3).
Market Forecast 3Figure 3 4.0 Percent
Personal 3.5
Consumption
Expenditures, 3.0
20 years 2.5
2.0
PCE Core YOY%
1y Average 1.5
1.0
0.5
0.0
Jun Jul Aug Sep Oct May
2001 2005 2009 2013 2017 2021
Source: BLS and Bloomberg as of July 1, 2021.
And although the rise in inflation data has our attention we can already see signs of price
pressure subsiding, notably in lumber (Figure 4) and some of the froth coming out of the housing
sector. A person only has to rebuild their deck or renovate a kitchen, once every so often or
during COVID lockdown and thus the increase in activity around home improvement. This
means the supply chain bottlenecks should decline as people resume their pre-COVID routines.
But the question on people’s mind is one of wage inflation. Is there evidence of persistent and
sustainable wage inflation? Anecdotes of these increases are everywhere but it’s unclear if they
will materialize in the data. Since the Global Financial Crisis the employee has been timid to ask
for a raise, with job safety fears outweighing more income. Perhaps there has been a shift, or the
beginning of a shift, for the employee to ask for a higher wage? The Quit (resignation) Rate might
be a good indicator as it reaches a two decade high (Figure 5). First, we must see what happens
as certain unemployment benefits expire. We have seen some employment growth follow and
with most of the additional unemployment benefits expiring this fall, we should see continued
growth in the labor force.
Figure 4 2,000 $
First Lumber
Contract 1,600
1,200
800
400
0
Mar Jul Nov Mar Jul
2000 2000 2000 2021 2021
Source: Chicago Mercantile Exchange and Bloomberg as of July 2, 2021.
Market Forecast 4Figure 5 3.0 Percent
Quit Rate
2.5
2.0
1.5
1.0
0.5
0.0
Dec May Oct Mar Aug Jan Jun
2000 2004 2007 2011 2014 2018 2021
Source: BLS and Bloomberg as of July 1, 2021.
Politics and Policy: The central focus for the money market investor will be the debt ceiling
resolution. The current thinking is a resolution will not be reached before the August recess but
will be reached in September. That leaves the Treasury with about $850 billion of spending room
going into August. It is expected that the $850 billion could last until mid-October before the
Treasury would have a technical default. Let’s hope for a painless resolution in September.
Another key focus will be prime and municipal money market fund reform. There is expectation
that the SEC will make an announcement prior to their regulatory agenda date of April 2022,
and perhaps as early as Q4 this year. There is broad consensus among industry participants
that a decoupling of liquidity gates and redemption fees from the weekly liquid asset metric is
necessary. We agree, but are feeling less confident in the belief that prime funds survive this
round of reform given recent headlines by Eric Rosengren. “The money-market fund reform
that occurred after the last crisis actually made things worse and so far there has not been
a solution,” Rosengren said, adding that prime money-market funds “need to be cleaned up.”
Randy Quarles also noted: “The March [2020] market turmoil is the second time in roughly a
decade that we have witnessed destabilizing runs on MMFs. More concerning this time, however,
is that we had taken steps between these events precisely to reduce the likelihood of such
runs.” The Financial Stability Board published their report with Quarles further stating, “that will
set out consequential policy proposals to improve MMF resilience”. Could capital and liquidity
buffers or swing pricing be in our future?
Lastly the fiscal spending continues. It appears the latest stimulus bill may be passed before the
August recess but it is not a lock. Republicans have seen most of their core demands met. The
deal at $579 billion is much smaller than what the Democrats wanted and primarily focused on
physical infrastructure. The issue of who will pay for this is still being negotiated. This deal should
be good for the Fed, if passed. It will give them the confidence to begin their tapering in the new
year as spending will continue support the economic recovery. How the spending continues is
unclear and we will not wade into those speculative waters.
Market Forecast 5Money Markets: Money market funds have been the beneficiary of the technical adjustment
in short-term rates (RRP and IOR) but thus far it has failed to affect fund yields. A few funds
have adjusted their waivers so their yields are higher, but the vast majority of fund yields have
remained unchanged at their previous floors. All money market funds still have some fee waiver
in place. We would not expect another adjustment in RRP or IOR until the FOMC begins raising
their Monetary Policy rate. In the meantime, there is some relief for fund companies to operate
off of zero and the negative rates are gone, at least for the near term.
Government money market fund weighted average maturities (WAM) grew shorter in the first
half of the year. As the curve continued to flatten it did not make as much sense to chase yields
further out on the curve. Weighted average lives (WAL, maturity duration) also shrank but only
by a few days. We would expect these durations to lengthen over the course of the second half
of the year. If the Fed has made their technical rate adjustment there could be selective buying
opportunities. Prime money market funds saw very little change to their WAM and WAL over the
course of the first six months of the year. With credit spreads at historic tight levels it does not
make sense to chase yield. As specific opportunities present themselves we will invest, otherwise
hold ground and wait.
Conclusion The next six months will have three significant events that could disrupt the money markets.
We see the probability of disruption as remote in all three. First, debt ceiling resolution: we
have been here before, have not seen a technical default, and this time should be no different.
Expect a resolution sometime in September. Second, the taper announcement could come as
early as September but as late as December’s FOMC meeting. We do not expect the timing to
change and the wind down of asset purchases should start in January 2022. Depending on this
timing, we could see some volatility in Treasury yields although we don’t expect much impact in
T-Bill yields. And lastly, prime fund regulation, which could impact commercial paper markets
negatively and push yields higher. As the end of the year approaches, it will be less likely to hear
an announcement as the SEC will not want to impact CP funding costs over year-end.
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